Balance of Payments
Overview Current Account : : The Current Account is one of two components within the balance of payments, the other one would have to be capital account. The current account = balance of trade + net factor income from abroad + net unilateral transfers from abroad, which means that the current account equals the change in net foreign assets. That means that the Current Account measures the flow of goods and services into and out of the country. This includes trades in goods (when one country buys a good in another country), trades in services (when one country pays for the services in another country), foreign investment income (when a country's firm opreates in another country and sends some of its profits back to is country), and transfers/remittances (when a foreign worker sends some of his/her income back to his/her country). All of these transactions can be shown through the circular flow model as well. : i.e., Current Account = Goods and Services : The Balance of Trade is the difference in monetary value of exports vs. imports within a given amount of time. If there is a trade surplus, a country is exporting more than it is importing. If there is a trade deficit, a country is importing more than it is exporting. : : An Invisible Balance is the difference between the value of services exported vs. imported within a given amount of time. Capital Account Capital Account is the inflow and outflow of capital that are related to assets, borrowing or lending activities in a country, and changes in official currency reserves held in a country's central bank. It is the net flow of public and private international investments in a country. It contains foreign direct investment (FDI), portfolio investment (when one country sells stocks to another country), and change in official reserves (when the central bank of one country buys a large quantity of foreign currency). Balance of Payments problems Defintion: The balance of payment is a record of all in- and outflows in a country arising from economic activity in the domestic and foreign sectors during a given time period. The balance of payment consists of the current account and capital account. The balance of trade must and should be balance! Meaning it must be ZERO! So if a country runs a current account deficit then it must funded by a capital account surplus. This surplus can either come from foreign direct investment, attracting short term inflows of funds through attractive rates of interest of the selling of government foreign currency reserves. Consequences of a current account deficit or surplus There are many consequences of a curent account deficit. One consequence is that inflation increases and taxes go up, which makes it harder to pay back the deficit. To solve this problem, the country's currency has to depreciate to make it easier to pay down debts. Wages also have to be cut, which is hard to accomplish because wages are sticky. Output will drop because workers won't take a wage cut so producers will lay people off. One cause of the deficit could be the cyclical fluctuations in the market that are illustrated by the Business Cycle. Also, in order to have a Current Account deficit, there has to be a Capital Account surplus to balance it out. To accomplish this, interest rates have to climb to get more investments into the country, among other things. Methods of correcting a current account deficit or surplus : Managed changes in exchange rate : Reduction in aggregate demand/expenditure-reducing policies : Changes in supply-side policies to increase competitiveness : Protectionism/expenditure-switching policies : Payments in exports and imports of goods, services, and financial capital, as well as financial transfers. Consequences of a capital account deficit or surplus Can lead to a large debt of the country. Caused by selling bonds to other countries, which moves assents from one country to another. If the net assets are lowered, we have national debt, or vise versa. Category:International Economics